For chief executives and other senior leaders, it is not unusual for 60-80% of their pay to be tied to performance – whether performance is measured by quarterly earnings, stock prices, or something else. And yet from a review of the research on incentives and motivation, it is wholly unclear why such a large proportion of these executives’ compensation packages would need to be variable. First, the nature of their work is unsuited to performance-based pay. As the incoming Chief Executive of Deutsche Bank, John Cryan, recently said in an interview: “I have no idea why I was offered a contract with a bonus in it because I promise you I will not work any harder or any less hard in any year, in any day because someone is going to pay me more or less.”
But moreover, as we will show, performance-based pay can actually have dangerous outcomes for companies that implement it.
Following the global economic crisis of 2008, large bonuses and stock options have been held responsible for overly risky behavior and short-term strategies. This has led to arguments that executive compensation needs to be organized differently so that the variable component motivates the right behaviors. Particularly in business schools, various Finance and Accounting professors have argued for including more long-term incentives, and for replacing variable pay packages that largely consist of stock options with a mix of bonds and stocks.